On February 5, 2008,
the FDIC selected 31 banks to participate in its Small-Dollar Loan Pilot
Program.1 The pilot is a two-year case
study designed to illustrate how banks can profitably offer affordable
small-dollar loans as an alternative to high-cost financial products,
such as payday loans and fee-based overdraft protection. Participating
banks provide quarterly information about their small-dollar loan programs,
which will be analyzed to identify and report on the most effective
features for creating profitable business models for such loans.

This article summarizes
the key parameters of the pilot, the proposals that participating banks
described in their applications, and the first quarter 2008 results.
Overall, banks in the pilot originated more than 3,100 small-dollar
loans, with a principal balance of about $3.7 million in the first quarter.
Eight of the banks reported on existing small-dollar loan programs,
while the remaining banks reported on new programs. It is difficult
to draw conclusions on the basis of only one quarter of data for mostly
new programs. However, an important initial observation is that small-dollar
loans have provided pilot banks with opportunities for cross-selling
other products, which creates significant potential for building profitable
customer relationships.

Parameters
of the Pilot

To be considered
for the pilot, an insured institution had to meet the following requirements:

A
composite “1” or “2” rating on its most recent
Safety and Soundness examination, and a Management rating of “1”
or “2”;

A
composite “1” or “2” rating on its most
recent Compliance examination;

At
least a “Satisfactory” rating on its most recent Community
Reinvestment Act evaluation; and

Not
currently subject to a formal or informal enforcement action or the
subject of an investigation or inquiry.

A key goal of the
pilot is to observe and encourage participating institutions to experiment
with providing safe, sound, affordable, and profitable small-dollar
loans. Therefore, the FDIC provided only general guidelines for banks
that sought to participate. It was anticipated that programs would be
generally consistent with the FDIC’s Small-Dollar Loan Guidelines,
with room for some exceptions.2 The following
are some of the primary features described in the Guidelines:

Loan
amounts of up to $1,000

Payment
periods that extend beyond a single paycheck cycle

Annual
percentage rates (APRs) below 36 percent

Low
or no origination fees

No
prepayment penalties

Streamlined
underwriting

Prompt
loan application processing

Automatic
savings component

Access
to financial education

Small-Dollar
Loan Program Proposals from Participating Banks

Banks that met the
selection criteria submitted an application to the FDIC describing their
existing or proposed small-dollar loan programs. The FDIC selected 31
banks, with assets ranging from $26 million to $10.4 billion, to be
part of the pilot (see Table 1). The participating banks are headquartered
in 17 states and have more than 560 branches located in 27 states. The
banks have on average 18 branches, although the number of branches varies
from 1 to 67.3

Eight of the 31
banks had small-dollar loan programs operating when they applied for
the pilot, while 23 banks described new programs. Many of the banks—
especially those with new programs—have already made changes based
on lessons learned during the design and launch phases. However, it
is useful to summarize their initial plans to track and report on the
outcomes of practices as the pilot proceeds.

Loan Characteristics.
At the time of application, 24 banks indicated that they would offer
only closed-end credit, two indicated that they would offer both open-
and closed-end credit, one indicated that it would offer only open-end
credit, and four were unclear as to the type of credit they would offer.
Banks in the pilot set initial maximum interest rates between 11 percent
and 36 percent, with an average of 18 percent. Two-thirds of the banks
planned to offer maximum interest rates in the 13 percent to 18 percent
range (see Chart 1).

Table
1

Small-Dollar
Loan Pilot Program Participants Vary in Size

Bank

Location

Total
Assets ($000s)

Number
of Branches

Amarillo
National Bank

Amarillo, TX

2,623,339

15

Armed Forces
Bank

Fort Leavenworth,
KS

803,840

51

Bank Commerce
Stilwell

Stilwell, OK

77,098

3

Bank Five

Fall River,
MA

671,445

13

BBVA Bancomer
USA

Diamond Bar,
CA

141,008

33

Benton State
Bank

Benton, WI

45,833

3

Citizens Trust
Bank

Atlanta, GA

354,311

10

Citizens Union
Bank

Shelbyville,
KY

579,178

20

Community Bank
& Trust

Cornelia, GA

1,148,448

44

Community Bank
Marshall

Marshall, MO

84,815

6

Community Bank-Wheaton/Glen Ellyn

Glen Ellyn,
IL

300,497

3

Cooperative
Bank

Jacksonville,
NC

958,700

24

First National-Fairfax

Fairfax, MN

26,010

1

First State
Bank

Tonganoxie,
KS

317,881

9

First United
Bank

Crete, IL

495,480

5

Kentucky Bank

Paris, KY

633,263

16

Liberty Bank

New Orleans,
LA

377,924

17

Liberty National

Paris, TX

246,857

3

Main Street
Bank

Kingwood, TX

201,244

3

Mitchell Bank

Milwaukee,
WI

81,555

11

National Bank
of KC

Overland Park, KS

942,043

6

Newbridge Bank

Greensboro,
NC

2,068,656

41

Oklahoma State
Bank

Guthrie, OK

41,804

4

Pinnacle Bank
Nebraska

Lincoln, NE

2,182,610

56

Red River Bank

Alexandria,
LA

647,274

12

Riverside National
Bank

Fort Pierce,
FL

4,519,993

67

State Bank
of Alcester

Alcester, SD

82,866

1

The Heritage
Bank

Hinesville,
GA

664,455

28

The Savings
Bank

Wakefield,
MA

389,335

9

White Rock
Bank

Cannon Falls,
MN

148,214

7

Wilmington
Trust

Wilmington,
DE

10,377,373

44

Note:
Data are from first quarter 2008.
Source: FDIC

Fifteen banks reported
that they would charge an application fee. The fees ranged from $18
to $61.50, with an average fee of $34. For banks providing APRs, the
average for their small-dollar loans ranged from 14 percent to 27 percent.

Underwriting
and Program Features. At the time of application, most banks
did not address the use of credit scores in underwriting, although four
banks specified that minimum credit scores would be required and three
indicated that there would be no minimum credit scores. Five banks indicated
that they planned to underwrite small-dollar loans within 24 hours of
application submission, while the other banks did not address turnaround
times.

Most banks did not
indicate whether deposit account relationships would be a prerequisite
for consumers receiving small-dollar loans. However, nine banks indicated
that they would require such a relationship. Of these banks, six indicated
that direct deposit of a paycheck or another income stream would be
mandatory. Moreover, four of these six banks (and two others) encouraged
automatic debit for note payments.

Seventeen banks
did not specify a consumer education component in their applications,
while 14 banks mentioned some sort of financial literacy component.
Many applications described consumer education very generally, for example,
mentioning that credit counseling would be made available as needed
or indicating that financial literacy materials are available in the
bank branch.

A few banks provided
more explicit descriptions of financial education. One application indicated
that three formal financial education classes would be required for
customers with very low credit scores. Another bank, which receives
referrals for its small-dollar loan program from a nonprofit organization,
described a comprehensive financial literacy package featuring budget
evaluation, case management, financial education, and a crisis-intervention
program that is a prerequisite to a consumer being referred for a small-dollar
loan. Another bank indicated that it would offer a $15 rebate of the
application fee to small-dollar loan applicants who completed a formal
financial literacy course.

Linked Savings
Programs. In launching the pilot, the FDIC indicated a particular
interest in programs with automatic savings features. The FDIC plans
to determine whether savings products linked to small-dollar loans will
reduce customer reliance on short-term, high-cost credit over time.
Sixteen banks planned to have mandatory savings elements in their small-dollar
loan programs, while another 4 encouraged savings and 11 indicated no
plans for linked savings accounts.

All of the savings
programs indicated that the savings accounts would partially collateralize
the loans and specified limits on withdrawals, generally tied to the
life of the loan. Six banks indicated that some portion of the amount
borrowed, ranging from 5 percent to 25 percent, would be added to the
principal amount of the loan and deposited into a savings account. One
bank indicated that a flat $500 would be added to the principal of each
loan and deposited into a savings account. Four banks said they would
require periodic deposits to savings accounts by adding some amount—$10 or $15, or 25 percent of the payment—to each scheduled loan
repayment.

Five banks indicated
that they would make financial contributions to the savings accounts
of borrowers as follows:

An
additional 10 percent in principal will be added to the loan and deposited
into a savings account. If the loan is repaid as agreed and the customer
is able to match the original deposit into savings, the bank will
refund application fees.

At
the time of the loan, the bank will open a savings account for the
customer and deposit $1. If the loan performs as agreed, the bank
will match customer deposits into the account up to $100.

At
the time of the loan, the bank will add $15 to the principal of the
loan and deposit it in a savings account. If the loan performs as
agreed, the bank will add 10 percent of the balance of the savings
account to the customer’s account.

At
the time of the loan, customers will have the option of opening a
savings account with as little as $5. The bank will match the opening
deposit up to $25.

Customers
will be encouraged to open a passbook savings account with as little
as $1 and a waiver of all service charges. The bank will match the
first $10 in deposits in each account.

Marketing
and Advertising.
Nine banks indicated that small-dollar loans would be offered only to
their existing customers, while the remainder were undecided at the time
of application or indicated that the program would be open to both existing
and new customers.

One
bank indicated that it planned to offer seasonal small-dollar loans around
holidays and during tax season.

The banks outlined
a number of diverse advertising strategies in their applications for
the pilot. They mentioned 66 different but related approaches, the most
common of which were media advertising (11 banks) and point-of-sale
displays (10 banks) (see Table 2).

Summary
of First Quarter 2008 Results

First quarter 2008
results were due May 15, 2008. Of the 31 banks in the pilot, 29 submitted
reports.4 Of those banks, 8 reported
on programs that existed before the pilot, and 21 reported on newly
developed programs. Four of the banks with new programs indicated that
they did not make any small-dollar loans during the quarter, as they
were finalizing aspects of their programs. The 25 banks that originated
small-dollar loans during the quarter all reported that they made only
closed-end loans.

Banks were asked
to provide separate data points for loans of up to $1,000 and more than
$1,000. This threshold is consistent with the Guidelines and was chosen
for the pilot to determine whether the $1,000 level can be used as a
“bright line” for a replicable small-dollar loan template
(see Table 3). In addition, five of the banks with existing programs
had disproportionately large programs compared with those of the other
banks; therefore, results for these banks are isolated from the rest
of the group in Table 3 to prevent skewing the loan volume. However,
with respect to basic loan characteristics—such as interest rates,
fees, and repayment terms—there is little difference between
banks that made a few loans and those that originated a large volume
of loans. Therefore, there is no distinction between large and small
programs for the small-dollar loan term data in Table 4.

Table
2

Pilot
Program Banks Have Diverse Marketing Strategies

Marketing
Category

Marketing
Approach

Number
of Banks Using Approach

Percentage
of Approach Usagea

Percentage
of Banks Using Approach (31 Banks)

Percentage
of Total Usage for Categoryb

Traditional bank marketing

Providing brochures

1

1.5

3.2

Direct mailing

4

6.1

12.9

Statement stuffers

4

6.1

12.9

37.9

Financial literacy
programs

6

9.1

19.4

Point of sale
displays

10

15.2

32.3

Staff or community-based marketing

Outbound calls

2

3.0

6.5

Staff incentives

1

1.5

3.2

Market to current
customers

4

6.1

12.9

Word of mouth

4

6.1

12.9

33.3

Referrals from
nonprofits

5

7.6

16.1

Via social
service organizations

4

6.1

12.9

Via churches

2

3.0

6.5

Media marketing

Media announcements

3

4.6

9.7

Media advertising

11

16.7

35.5

21.2

Internet marketing

Bank website
advertising

4

6.1

12.9

Internet advertising

1

1.5

3.2

7.6

TOTALS:

66

100.0

N/A

100.0

Source:
FDIC.

aSixty six distinct,
but often related, approaches were noted in the bank applications.
This column shows the distribution of the use of the 66 approaches.

bThe 66 approaches were organized into four marketing categories. This column shows the distribution of the use of the four categories.

As shown in Table
3, 20 banks originated 1,523 loans of $1,000 or less with combined principal
of about $1 million. Four banks originated almost 1,400 of these loans,
with one particularly active bank reporting 966 loans of $1,000 or less.
Excluding these large originators, the 16 banks that made small-dollar
loans up to $1,000 originated eight loans on average.

For loans above
$1,000, 15 banks originated 1,617 loans with combined principal of about
$2.7 million. Five banks originated more than 1,500 of these loans,
with one bank reporting 623 loans above $1,000.

Excluding these
large originators, the ten banks that made small-dollar loans above
$1,000 originated eight loans on average.

Table 4 summarizes
the basic characteristics of small-dollar loans made in first quarter
2008. For banks that made loans of $1,000 or less, the average loan
size was $678, the average loan term was ten months, and the average
interest rate was 15.1 percent. Seven banks that originated loans of
$1,000 or less reported APRs averaging 23.8 percent.

For banks that made
loans above $1,000, the average loan size was $1,695, although two banks
in this group reported making average loans greater than $3,000.5
The average loan term for loans in excess of $1,000 was 17 months, and
the average interest rate was 15.5 percent. Four banks that originated
loans in excess of $1,000 reported APRs that averaged about 16.5 percent.

Table
3

Small-Dollar
Loan Pilot Program 1Q08: Summary of Loan Number and Volume Data

Number
of Banks Reporting

Total

Average

Minimum

Maximum

Loans
Up to $1,000

All
Banks

# of Notes

20

1,523

53

1

966

Note Volume

14

$1,013,118

$72,366

$401

$641,050

Banks
Originating Fewer Than 50 Loans

# of Notes

16

132

8

1

29

Note Volume

10

$71,147

$7,115

$401

$21,710

Banks
Originating More Than 50 Loans

# of Notes

4

1,391

348

55

966

Note Volume

4

$941,971

$235,493

$24,450

$641,050

Loans
Over $1,000

All
Banks

# of Notes

15

1,617

108

1

623

Note Volume

12

$2,696,996

$224,750

$1,500

$1,207,145

Banks
Originating Fewer Than 50 Loans

# of Notes

10

75

8

1

28

Note Volume

7

$124,109

$17,730

$1,500

$78,420

Banks
Originating More Than 50 Loans

# of Notes

5

1542

308

57

623

Note Volume

5

$2,572,887

$514,577

$121,544

$1,207,145

Source:
FDIC.

Table
4

Small-Dollar
Loan Pilot Program 1Q08: Summary of Loan Characteristics

Number
of Banks Reporting

Average

Minimum

Maximum

Loans
Up to $1,000

Loan
Amount

14

$678

$100

$1,000

Term
(months)

19

10

3

27

Interest
Rate (percent)

19

15.05

5.25

33.00

Non-zero
Fees (dollars)

4

$40

$12

$65

APR

7

23.80

11.00

34.00

Loans
Over $1,000

Loan
Amount

12

$1,695

$1,202

$3,750

Term
(months)

14

17

5

36

Interest
Rate (percent)

15

15.53

9.21

31.41

Non-zero
Fees (dollars)

4

$59

$25

$134

APR

4

16.48

11.19

22.88

Source:
FDIC.

Small-Dollar
Loans Open the Door to Profitable Relationships

Armed
Forces Bank: Using Small-Dollar Loans to Retain Customers

Armed Forces Bank in Fort
Leavenworth, Kansas, with more than $800 million in total assets and
51 branches, has been originating small-dollar loans for about four
years. The program has about $4.5 million in loans outstanding (about
$1.8 million was booked in first quarter 2008) and is targeted almost
exclusively to military personnel. Armed Forces Bank generally offers loans from $250 to $2,000. All loans
are closed-end transactions for up to 24 months. The interest rate is 18 percent, and there are
no fees. The borrower must open an account with the bank and maintain
direct deposit. Loan payments are automatically debited from the borrower’s
account.

Armed Forces Bank views its small-dollar loan as a retention product that helps customers who are experiencing problems regain their financial integrity and allows them to remain in a banking relationship. Armed Forces Bank reports that it generally breaks even on this program and that relationships with small-dollar customers are just as profitable as those with customers who use more traditional products and services. In addition to obtaining the use of funds from the mandatory direct deposit, the bank has been successful in migrating small-dollar loan customers to other products. In first quarter 2008, 64 small-dollar loan customers who paid as agreed migrated into traditional loan products.

Pinnacle
Bank: Using Small-Dollar Loans to Create New Relationships

Pinnacle Bank, headquartered
in Lincoln, Nebraska, is a $2.2 billion bank with 56 branches. Pinnacle
Bank’s small-dollar loan program is new; the first loans under
the program were originated during first
quarter 2008. The program was initially piloted in two branches in Lincoln
and Omaha, and was targeted to the Latino market. Pinnacle originated
19 loans under its small-dollar loan program through the first quarter.
All loans are closed-end, with terms ranging from seven to ten months,
and interest rates are about 10 percent. Fees of up to $50 may be assessed,
but beginning in third quarter 2008, half of the fee will be rebated
if the customer opens a savings account.

While it is too
early to assess the overall profitability of the program, Pinnacle Bank
has noted that the
program has not negatively affected bank profitability. Pinnacle Bank
views the small-dollar loan as a way of introducing new customers to
the bank and noted that 18 of its 19 small-dollar loan customers have
expanded their relationship with the bank by migrating to other products.
Most have added checking accounts; 14 have debit cards; 5 have savings
accounts; 1 has a certificate of deposit; and 1 has opened an Individual
Retirement Account. Pinnacle Bank has been pleased with the response
to the new program so far. Beginning in second quarter 2008, the program
was expanded to all branches in Lincoln and Omaha, and Pinnacle will
soon begin a marketing campaign with direct mail and newspaper advertisements.
The marketing plan will specifically address the encouraged savings
component, offering borrowers a coupon for $25 toward new saving. Advertising
will also directly position Pinnacle’s small-dollar loan as an
alternative to payday lending.

Other Program
Statistics. Since most of the small-dollar loan programs are
new and reporting has just begun, only five banks reported delinquencies
for loans made in the first quarter, ranging from 1 to 19 loans per
bank.

Of the 29 banks
that reported first quarter results, linked savings are mandatory for
13 programs, strongly encouraged for 8 programs, and not required for
8 programs. Thirteen banks reported that a total of 46 linked savings
accounts were opened. Ten banks reported an approximate aggregate balance
of $21,300 in linked savings accounts.

Three banks noted
that they believed small-dollar loan customers were using fewer high-cost
debt products, although these observances were mostly anecdotal.

Few banks provided
profitability data for their programs, primarily because most programs
are new and have a relatively low volume of loans. However, three banks
indicated that they broke even on the small-dollar loan product, while
two indicated that they did not. Including deposits and other accounts,
five banks reported that the overall relationship with small-dollar
loan customers was profitable, while two reported that it was not.

The relationship-building
aspect of the small-dollar loan product could prove to be important
in determining the feasibility and profitability for banks in the pilot.
More than half (13) of the 25 banks that reported first quarter results
indicated that customers have already migrated to other bank products
from the small-dollar loan product, while only 2 banks reported no migration.
Deposit accounts are the predominant products that pilot banks have
opened for small-dollar customers, although other, more sophisticated
products also have been provided. One bank that had an existing program
indicated that many small-dollar loan customers are approved for auto
loans after their initial small-dollar loan is paid and that “auto
loans appear to be the next step in establishing a lending relationship
with small-dollar loan customers.”

Two case studies
presented in the text box highlight the profit potential for cross-selling
to small-dollar loan customers.6 Armed
Forces Bank has the largest and oldest program in the pilot; it reports
that while the small-dollar program breaks even, the overall customer
relationship is as profitable as a traditional relationship.
Pinnacle Bank created a new small-dollar loan program and is not yet
able to assess its profitability. However, it reports strong migration
to other bank products (18 of 19 borrowers) and views the small-dollar
loan as an important draw for new customers.

Conclusion

Although the Small-Dollar
Loan Pilot Program is still in its initial stages, participating banks
are already demonstrating innovative strategies in areas such as advertising
and linked savings that may prove to be replicable for other banks.
Banks in the pilot are well within the 36 percent maximum APR established
in the FDIC’s Small-Dollar Loan Guidelines, and five banks thus
far have reported using the small-dollar product as a cornerstone for
profitable relationships. These early results provide some indication
that banks can profitably provide affordable alternatives to high-cost,
short-term credit. The FDIC will continue to explore profitability and
other noteworthy features of participating bank programs as the pilot
progresses.

The authors
would like to thank the following persons for their review of this article:
Andrew Stirling, Special Advisor, Division of Supervision and Consumer
Protection, FDIC; Robert Dixon, Senior Vice President, Lending, Armed
Forces Bank; and Dennis Thomas, Director of Regulatory Compliance, Pinnacle
Bank.

4
The two banks that did not submit reports indicated that they did not
originate
small-dollar loans in first quarter 2008.

5
In this initial reporting period, to encourage innovation, there was no
limit on the loan amount that could be included in the pilot. An unintended
consequence of not having an upper limit was that a few banks reported
several larger loans that may have skewed the average. As the result of
a discussion with participating banks about what constitutes a small-dollar
loan, a reporting limit of $2,500 will be imposed for future data submissions.

6
Banks listed in this article are for illustration only. The FDIC does
not endorse any bank or product.